Despite recent stronger economic data, the United States is likely to fall into a recession that will spread globally. The reason? The US has too much debt – and reducing it hurts growth.
After three decades of US consumers and financial institutions globally taking on more debt, they're now reducing debt – but it's a multiyear process and far from finished. US and European governments are also under pressure to cut debt after incurring huge deficits in the 2007-09 Great Recession. As a result, I expect slow economic growth and high unemployment to persist in the US and Europe.
In Europe, real growth as measured by gross domestic product is probably already headed down. Growth was a mere 0.6 percent in the third quarter in the 17-country eurozone. Unemployment in the eurozone was 16.3 million in October – the highest since record-keeping began in 1995 – and the unemployment rate rose to a high of 10.3 percent in October.
After the Great Recession, it's clear that a common euro currency without a centralized fiscal policy is unstable. No long-term solution is in sight, but strong eurozone countries like Germany believe continuing bailouts of weak economies like Greece, Spain, Italy, and Portugal are preferable to an outright collapse of the eurozone – in effect, they're kicking the proverbial can down the road. The effects on the US of a European recession next year are small, but the financial risks due to intertwined banks are great.
Meanwhile, efforts by China to cool her property bubble and high inflation are working, but a hard economic landing is likely to result, with growth rates of 5 to 6 percent versus the 8 percent-plus growth rate needed to create jobs for China's burgeoning population. The ongoing collapse in commodity prices suggests slowing demand from China. Stock markets are also great predictors of economic activity. The Shanghai Composite Index fell 13.4 percent in 2010 and was off 27 percent between mid-April and mid-December.
In the US, the key to the economic outlook is consumers, whose spending accounts for 71 percent of GDP, but they're now embarking on a saving spree to replace their 25-year borrowing and spending binge. And there's no other sector – government, the Federal Reserve, or the private sector – that can provide meaningful economic growth in the next year or so.
In the postwar era, recessions have been inaugurated by the Fed boosting interest rates to reduce inflation. That prospect isn't in sight. But with slow economic growth likely in 2012, it wouldn't take much of a shock to push growth into negative territory. That could come from a sizable drop in housing prices and the discouraging effects on consumer spending. The spreading effects of the European financial crisis and recession could also be the trigger or maybe some of each combined with a post-Christmas consumer spending retrenchment.
This won't be another Great Recession. I'm forecasting a 2.2 percent peak-to-trough decline in real GDP that lasts for a year (versus the 18-month 5.1 percent plunge in the Great Recession). Europe's recession may be deeper with the financial crisis there and the region's real economic decline reinforcing each other. Combining economic downturns in Europe and the US with a hard landing in China means that a global recession next year is also likely, before the stage is set for a weak US and global recovery in 2013.